Consequences of Not Reporting Income from a Rental Property

Not reporting your rental income could be an expensive mistake.

Failing to report income from your rental property is a serious issue. While the IRS sends relatively few people to jail, the penalties that they levy add up very quickly, and their methods of collecting unpaid taxes and penalties can be crushing. Furthermore, landlords often have less taxable income than they may realize, making it particularly unwise not to report the rental income.

How to Report Rental Income

Reporting rental income requires adding the Schedule E form to your 1040 tax return. Basic information about your property gets entered at the top of the form, and your income is reported on lines 3a, 3b and 4. You then subtract all of your expenses on lines 5 through 19 to generate a total profit or loss that's listed on line 26. The IRS lets you claim a number of different expenses against your income, and certain expenses like depreciation don't require spending money on your property.

Failure to Report Income

Failure to report income is exactly what it sounds like: It is when you earn money and do not include it on your tax return. While the most egregious example would be earning rent and pocketing the money, landlords might do more subtle things. For example, they could fail to report retained security deposits or understate the amount collected from coin-operated laundry machines that are on their property. Such tactics are considered illegal.

Penalties

The IRS can levy a number of penalties on landlords who fail to report rental income. If the failure to file is a legitimate mistake, the IRS will levy their "failure-to-pay" penalty, which accrues at a rate of 5 percent per month up to a maximum of 25 percent of the total tax due. However, if a landlord intentionally omits income from their return, the IRS will levy their penalty for a fraudulent return, which is 15 percent per month up to a maximum of 75 percent. These penalties are in addition to the taxes that still are owed.

Interest

The IRS doesn't just charge penalties, though. They also levy interest on the unpaid taxes, penalties, and the interest that is already due. There are no time limits on the interest, which is calculated based on the federal short-term rate plus a 3 percent spread. As of October 2012, the penalty interest rate is 3.23 percent; although, it likely will adjust upward in the future.

Collection Methods

Landlords that are caught failing to report rental income and cannot work out a payment arrangement with the IRS will end up going through the IRS' collection process. As a part of the process, the IRS can seize bank accounts and use the proceeds to pay down tax debts. They also can seize tax refunds, file liens against properties, and garnish wages. IRS wage garnishments are particularly harsh because rather than limiting how much they can take, the law limits how much they have to leave behind.

About the Author

Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.